By Alex Tarrant
The International Monetary Fund is advising the government to widen New Zealand’s tax base for capital gains and to introduce a land tax.
The recommendation comes after a regular annual ten day visit from IMF Mission Chief for Australia and New Zealand Ray Brooks, and is set to be presented to Finance Minister Bill English on Monday afternoon.
The government has already ruled out a broader capital gains tax and a land tax in its response to the Tax Working Group's recommendations in Budget 2010. Instead it chose to lower income and corporate tax rates, increase GST, and make changes to building and capital depreciation rules.
“We’re advising the government to widen the tax base for capital gains, and introduce a land tax to fund other tax rate reductions,” Brooks said in a media briefing before meeting the Finance Minister.
The level of the land tax would be left up to the government to decide.
“The particulars I would leave up to the government to decide, but the idea of this would be to broaden the tax base and also would help address some of the issues raised by the Savings Working Group concerning the penalty in the tax system against deposits in banks," Brooks said.
The IMF also supported the Saving Working Group’s suggestion for indexing interest income and expenses for inflation, Brook said.
The IMF had previously recommended the broadening of the tax base and moving away from income taxes to greater reliance on GST, but had touched upon capital gains and land taxes due to the working group reports that had been presented to the goverment.
PM says 'no'
Prime Minister John Key reiterated later a land tax and broader capital gains tax were still off the cards. Asked whether the implementation of one or the other could allow government to reduce income taxes to give people more income to spend, he replied:
“At the risk of repeating myself from last year, we looked at a land tax, and land taxes, one, reduce the value of land in New Zealand, by definition, and it has an impact on every single homeowner in New Zealand."
“ I wouldn’t have thought we’d want to do that on the back of a very weak housing market at the moment,” Key said at his Monday media briefing in the Beehive.
“Capital gains tax is already in place. They don’t produce you a lot of revenue upfront, so they wouldn’t actually pay for the Christchurch earthquake in day one, and in our view they are an inefficient form of taxation,” he said.
House prices overvalued
Brooks said house prices in New Zealand could be 15-20% overvalued at the moment, although there was uncertainty around the figure.
“You can look at some very simple metrics and get some very large numbers. If you look, for example, at the house price to income ratio, that’s about 40% above a long-run average for the last 40 years for that ratio. You look at the ratio of prices – houses - to the rental income, that’s similar," he said.
“But other models that take account that over time there’s been a quite a substantial fall in mortgage interest rates in New Zealand – and that enables people to service a much bigger mortgage on a more expensive house – that might suggest an overvaluation in the range of 15-20% at present when you look across countries.”
New Zealand’s terms of trade was also a factor in house prices.
“The recent improvement in the terms of trade helps us out as households see that they have higher permanent income. It’s certainly a case in Australia where we see the house price overvaluation as a little bit lower, in the range of 5-10%, because the terms of trade there has been much stronger," Brooks said.
"So if you have a fall in the terms of trade, perhaps sparking a fall in house prices, or whatever shock may bring house prices back to equilibrium, that may have some impact on banks, but we doubt that that alone will hurt banks," he said.
"New Zealand’s different to many other countries, there’s full-recourse lending, you don’t get people walking away from their home.
"But if you add a combination of shocks to house prices, to the terms of trade, to that led to a recession and unemployment, you could see that banks could be hurt by that," Brooks said.
“I would add the footnote to that on the uncertainty surrounding the impact of the earthquake on the housing market, as you’ve taken out housing supply. The scale of that is a bit unclear,” he said.
Deficit to hit 9% of GDP on lower tax take
The IMF's growth outlook was uncertain at present due to the stalled recovery since mid-2010, reflecting the very soft domestic demand growth as households and businesses became very cautious about debt.
“And we’ve had the impact of the earthquake which creates considerable uncertainty around the outlook, particularly related to the timing and the size," Brooks said.
The IMF was expecting GDP growth this calendar year of 1%, and a pick up next year of around 4%. It is also projecting the 2010/11 fiscal deficit to reach about 9% of GDP.
“That [the deficit forecast] is much larger than budgeted,” Brooks said.
Finance Minister Bill English last week said the government’s operating deficit, before gains and losses, deficit should hit about 8% of GDP, or NZ$16 billion, in the current year as government paid the initial costs of the February 22 earthquake and took to books additional costs of future years.
“We have a slightly slower growth rate affecting the revenue numbers – some slight differences in our forecast for revenue for the coming year,” Brooks said.
The IMF’s main advice was for the government to still return the books to surplus by 2014/15.
"Prior to the earthquake, the Prime Minister had announced the intention to return to a small surplus by 2015/15. That’s a little earlier than previously planned," Brooks said.
"We think that, although the earthquake has worsened the fiscal situation in the near-term, we think it’s both feasible and desirable to come back to the medium-term target for a number of reasons. It would help build a buffer against future shocks," he said.
"And while New Zealand’s public debt is expected to remain low by advanced country standards, New Zealand has very large net foreign liabilities – about 85% of GDP – and that calls for fiscal prudence.
"Particularly if global interest rates start to rise, low public debt in New Zealand would help contain the cost of New Zealand’s capital.”
(Updated with comments on fiscal response, GDP, video, PM's response, detail on IMF view on house prices.)